1. Suppose The Washington Post Company (WPO) has no debt and an equity cost of capital of 8.8%. The average debt-to-value ratio for the software industry is 12.6%. What would its cost of equity be if it took on the average amount of debt for its industry at a cost of debt of 6.4%?
2. Hubbard Industries is an all-equity firm whose shares have an expected return of 10.0%. Hubbard does a leveraged recapitalization, issuing debt and repurchasing stock, until its debt-equity ratio is 0.56. Due to the increased risk, shareholders now expect a return of 14.8%. Assuming there are no taxes and Hubbard's debt is risk-free, what is the interest rate on the debt?
3. Arnell Industries has just issued $20 million in debt (at par). The firm will pay interest only on this debt. Arnell's marginal tax rate is expected to be 35% for the foreseeable future.
a. Suppose Arnell pays interest of 9% per year on its debt. What is its annual interest tax shield?
b. What is the present value of the interest tax shield, assuming its risk is the same as the loan?
c. Suppose instead that the interest rate on the debt is 11%. What is the present value of the interest tax shield in this case?
4. Rogot Instruments makes fine violins and cellos. It has $1.2 million in debt outstanding, equity valued at $2.2 million and pays corporate income tax at rate 35%. Its cost of equity is 11% and its cost of debt is 6%.
a. What is Rogot's pretax WACC?
b. What is Rogot's (effective after-tax) WACC?
5. Rumolt Motors has 19 million shares outstanding with a share price of $20 per share. In addition. Rumolt has issued bonds with a total current market value of $212 million. Suppose Rumolt's equity cost of capital is 10%, and its debt cost of capital is 5%.
a. What is Rumolt's pretax weighted average cost of capital?
b. If Rumolt's corporate tax rate is 38%, what is its after-tax weighted average cost of capital?
6. Milton Industries expects free cash flow of $9 million each year. Milton's corporate tax rate is 35%, and its unlevered cost of capital is 14%. Milton also has outstanding debt of $46.97 million, and it expects to maintain this level of debt permanently.
a. What is the value of Milton Industries without leverage?
b. What is the value of Milton Industries with leverage?
7. With its current leverage, Impi Corporation will have net income next year of $6 million. If Impi's corporate tax rate is 30%, and it pays 6% interest on its debt, how much debt can Impi issue this year and still receive the benefit of the interest tax shield next year?
8. Markum Enterprises is considering permanently adding an additional $87 million of debt to its capital structure. Markum's corporate tax rate is 38%.
a. Absent personal taxes, what is the value of the interest tax shield from the new debt?
b. If investors pay a tax rate of 45% on interest income, and a tax rate of 20% on income from dividends and capital gains, what is the value of the interest tax shield from the new debt?